Financial Peace University Lesson 10 – From Fruition to Tuition
Planning for Retirement and College
This week Ramsey introduced Baby Step 4 (and #5 but more on that later) to us
Baby Step 4: Invest 15% of your household income into Roth IRAs and pre-tax retirement plans.
After you have paid off all your debt, except maybe your mortgage, and fully funded a 3-6 month emergency fund, it is not time to start thinking about and planning for your future.
Always save for long-term goals in tax-advantaged plans
Ramsey recommends that you should do all of your retirement savings using tax-favored money. Such tax-favored plans include the IRA, 401(k), 403(b), 457, and SEPP.
Dave really likes Roth IRAs which are funded with after-tax money but grow completely tax-free. There are many choices of investments in Roth IRAs, you can effectively invest more money than a standard IRA because you are using after-tax money, and if you do everything that Ramsey teaches (or at least most of it) you will probably end up in a higher tax bracket in retirement so having a Roth IRA is great at that point in time. Furthermore, you can use your Roth IRA as a last resort fall-back if you are in a very dire situation as you can make tax-free and penalty-free withdrawals at any time up to the amount of your contributions.
Remember that there are income limits to using Roth IRAs so check with the IRS or your tax adviser for the current limits. For those that don’t qualify for a standard Roth IRA, you might want to check with your employer to see if they provide a Roth 401k option. It works generally the same as a Roth IRA but there are no income limits and is subject to the higher yearly 401k contribution limits instead of the Roth IRA limits.
Ramsey’s suggestions for funding your retirement
- Fund your 401k (or similar) up to the maximum employer match amount (if applicable)
- Above that amount, fund Roth IRAs.
- After maxing out your Roth IRA contribution, complete the 15% of your income by funding your 401k again.
One big no-no
I know it sounds like a great idea, but Dave recommends that you should never borrow money from your retirement plan. Sure, you will be paying yourself back the interest, but that rate will be much lower than you might earn over time in a diversified, long-term portfolio. The most important consideration, however, is if you happen to lose your job, you must pay all the money back in a short period of time or else the IRS treats it as an early withdrawal and you will pay taxes and penalties on the money you borrowed. And how are you going to pay that money back within the time limit when you no longer have a job?
Baby Step 5: Save for your children’s college using tax-favored plans
Once you get baby step 4 setup, you are ready to start saving for your children’s college education (of course, if you don’t have kids or they are grown and finished with college, you can skip this step).
Start with the ESA
Ramsey recommends using the Education Savings Account (sometimes referred to as the “Education IRA”). You can save $2,000 per year, per child into an ESA and this money grows and can be used for education expenses tax-free. Similarly to the Roth IRA, there are income limits for using the ESA that you should check into.
Next step is the 529
If you want to do more saving that the ESA allows or you don’t meet the income requirements, he recommends using a 529 plan. He recommends, however, that you use the type of 529 that leaves you in control of the mutual funds in which you are invested. He warns to never invest into a plan that freezes your options or automatically changes the investments as your child ages.
Caution
Dave wrapped up this week’s lesson by laying out a few “nevers” to follow (or avoid, as it were) while saving for college:
- Never save for college using insurance products
- Never save for college using savings bonds – the rates of return are too low.
- Never save for college using prepaid college tuition plans – the college tuition rate of inflation is 7%, so you will effectively earn that rate on your investment when you could be earning more in a diversified portfolio of mutual funds.
Wrap-up
This lesson was very interesting to my wife and me – this is where we’re at right now. We are trying to ratchet up our retirement savings such that we can retire one day and also trying to save up to fund at least some of our kids’ college education. For retirement, we are actually pretty close to investing 15% (14.8%) if you include my company match…interestingly Dave didn’t really mention in the lesson whether he includes the company match in that 15% figure.
If you only do one of these steps, opt for retirement savings
One final thing to remember – while both steps are important, saving for retirement is more important. If you can only do one, do the retirement saving. Think about it – you can get a scholarship or work-study or, as a last resort, a student loan to go to college. There are no scholarships for retirement, however. It is certainly a noble pursuit to scrimp and save to put your children through college. I just hope that they get a good job so they can afford to take care of you because you were lax in your retirement planning. At the very least, you want to be able to invest your time and energy in your grandkids; you don’t want to be forced to divert that time because you have to work full-time at Wal-Mart when you are 75 years old!
Check out my previous FPU posts:
- Introduction
- Lesson 1 – Super Saving
- Lesson 2 – Relating with Money
- Lesson 3 – Cash Flow Planning
- Lesson 4 – Dumping Debt
- Lesson 5 – Credit Sharks in Suits
- Lesson 6 – Buyer Beware
- Lesson 7 – Clause and Effect
- Lesson 8 – That’s Not Good Enough
- Lesson 9 – Of Mice and Mutual Funds
Financial Peace University Lesson 9 – Of Mice and Mutual Funds
Understanding Investments
This week we listened to Dave Ramsey discuss various types of long-term investments. For long-term wealth building, putting your money in a standard bank account is just not going to cut it. You need to use some other vehicle that will outpace inflation and enable you to end up with more money than you start with. If you don’t need access to your money for at least five years, then that money can be invested instead of just saved.
Keep it simple, stupid!
Besides the statement directly above, Ramsey provided a few more rules for investing:
- Never invest purely for tax savings
- Never invest using borrowed money (that certainly should not shock anyone!)
Diversification is the most important tip
Diversification means to “spread around” and it lowers your overall risk. Ramsey presented an interesting example in the workbook. Imagine two different investors. The first puts $10,000 into a investment that earns 7% interest for 25 years. The second puts $2,000 dollars into five different investments and earns the following returns over the 25 years: loses all $2,000, 0% (under mattress), 5%, 10%, 15%. Maybe surprisingly, at the end of 25 years the second investor will have almost $59,000 more!!
A (very) basic primer on investments
Remember that all investments carry different degrees of risk and that as risk increases so does the potential rate of return. Liquidity is the ease with which you can access your money (cash is very liquid while equity in a house is not very liquid at all). Conversely to risk, as there is more liquidity, there is typically less potential return. Finally, remember that there are two types of risk to consider for an investment – the investment risk itself (if I buy that Enron stock, is there a chance it will go down in value?) and inflation risk as it eats away at your money over time.
Different types of investments
Ramsey spent the remainder of the class touching on a few of the various types of investments out there. I will just highlight some of those he mentioned.
- Single Stocks – This is small piece of a company that you own. You gain a return when the value of the company increases or when they pay you some of their profit (dividend). These are extremely risky and should be kept to less than 10% of your net worth. Ramsey does not own any individual stocks.
- Bonds - This is debt that you lend to a company. Your return is the interest rate that the company pays you and the fluctuation in the price of the bond. Ramsey does not own any individual bonds either.
- Mutual Funds – An investment where many people put money into a pool to buy a bunch of different stocks providing diversification. The pool is is usually managed by a professional portfolio manager. Mutual funds are a good long-term investment and Ramsey does own shares of a number of funds.
- Rental Real Estate – This is a good investment (Ramsey does own paid-for rental real estate) but he suggests that you have a lot of cash before getting involved with real estate investing. His recommendation is to buy slowly with cash only. Also, a reminder from him is that your money is made at the purchase – so be patient and only buy big bargains.
Bad Investments
Ramsey does not recommend the following investment vehicles (in fact, he warns to stay far away from them):
- Gold
- Commodities & Futures
- Day Trading
- Viaticals
Dave’s suggested mutual fund portfolio
Ramsey suggested creating a diversified long-term portfolio by purchasing different mutual funds in the following proportions:
- 25% Large-cap mutual funds (growth & income)
- 25% Mid-cap mutual funds (growth)
- 25% Small-cap mutual funds (aggressive growth)
- 25% International mutual funds
“Cap” means the capitalization of a company which means how big the company is. So, a large-cap mutual fund owns companies like IBM and/or GE. By purchasing a few different mutual funds to create a similar portfolio, you are able to reduce your risk (relatively). To recap: putting all your money into some shares in a single company is very risky, purchasing a mutual fund is much less risky, and purchasing a diversified set of multiple mutual funds is even less risky. Again, the term “risky” is all relative as we have seen over the past year as all types of funds decreased in value. So, remember that investing in stocks and mutual funds is a long-term endeavor!
A good tip or two
Ramsey concluded the class by giving out the following two tips:
- If you don’t understand the workings of an investment well enough to be able to teach it to someone else, then you don’t understand it well enough to buy it!
- Build wealth slowly – Don’t look for short-cuts; remember who wins in the tortoise and the hare story (hint – it’s the turtle).
One other point out of our discussion
Right at the end of class during our discussion, someone asked the following question – “When was this video made?” I couldn’t really hear what he asked and his comments after the question (everyone was starting to pack up and leave) during class, so I asked my wife. His point was to insinuate that Ramsey would have changed the video after what happened in the US stock market since late 2008. I remarked to her, “So he kinda missed the entire point of the lesson then?”
Here’s a reminder from me (not Dave Ramsey though he might say the same thing): You don’t change long-term strategy based on transient short-term events. Ramsey tried to explain this during class when he took a number of events that caused a significant market drop and showed that in almost every case the market had recovered within a year of the triggering event. Remember, the market does go up and it does go down too; thus it is possible that your investments will also go down (not just up). That is why it is important to view investing as a long-term process. If you need that money in the near-term, the market is not a good place to put it (Remember the five-year rule).
Check out my previous FPU posts:
- Introduction
- Lesson 1 – Super Saving
- Lesson 2 – Relating with Money
- Lesson 3 – Cash Flow Planning
- Lesson 4 – Dumping Debt
- Lesson 5 – Credit Sharks in Suits
- Lesson 6 – Buyer Beware
- Lesson 7 – Clause and Effect
- Lesson 8 – That’s Not Good Enough
Financial Peace University Lesson 8 – That’s Not Good Enough!
How to Buy Only Big, Big Bargains
This week’s lesson centered around making purchases, especially bigger ones, and getting really good deals on those purchases. The main way to accomplish this, and what Dave spent most of the lesson discussing, was through negotiation.
Negotiate everything
First he pointed out the difference between the US and most other cultures of the world. In the US for some reason, most people are very reluctant to ask for bargains. Of course this is quite the opposite in numerous other countries where haggling takes place over just about every purchase.
So, the first thing you need to do is change your mindset – it is ok to haggle and get a good deal. Negotiate everything and don’t be afraid to ask for a good deal. What’s the worst thing that could happen – they say “no?” If that happens, you’re no worse off than if you hadn’t asked at all, so who cares? If you ask, you might get a great deal, if you don’t ask, you definitely will not get that deal.
Dave’s Seven Basic Rules of Negotiating
- Always tell the truth
- Use the power of cash – it is emotional, visual, and has immediacy. Ramsey likes to tell stories of how when he is looking for a really good deal, he walks into stores with hundred dollar bills. He claims that he can usually get a really good deal when he starts peeling off and counting those $100 bills in front of the salesperson. He also seems to have a ton of fun doing it – I think I need to try this for our next significant purchase.
- Use your “walk-away power” – it is critically important that you keep an emotional distance from the item. If the salesperson knows that you have already bought the item emotionally, then there is no need to negotiate with you, is there?
- Shut up – ask questions, gather information, and just listen. If you let the other person do most of the talking, you might just be surprised what you end up hearing!
- “That’s not good enough.” – This is Ramsey’s favorite phrase during a negotiation. He suggests saying it and seeing what happens.
- Good guy, bad guy – when someone is using this technique on you, the way to neutralize it is to get to the bad guy and directly negotiate with him/her.
- Use the “If I” take away technique – in other negotiating classes I’ve taken this was referred to as “nibbling.” When you are closing in on a deal, use this technique to take a few final nibbles and get a deal with which you are really happy. An example might be, “If I purchase this widget at that price, I need you to throw in free widget washing for a year.”
Have patience
Having patience is a usually necessary for getting a great deal. As mentioned, maintaining that walk away power is very important. So, maintain it, and use it when you need to.
Remember, it’s your money, no one can force you to buy a product at a price with which you are not happy. When I was negotiating one of our cars a few years back, I remember telling myself this over and over. You get into a car dealership and they try to make you feel bad about not giving them their price and all this and that…so remember this tip.
Give it a try
As I mentioned previously, you don’t really have anything to lose by asking for a better deal. I admit that I don’t negotiate often. Usually, I’ll sit through a session like this and get all fired up about negotiating. I’ll then go out and try it and almost always have success…but over time I just stop trying it.
The last major thing I negotiated took place a few years ago when we needed to get a liner put into our chimney. The quote I had was $2400. So, I exercised some patience and waited about 5 months until March, which is typically a time that chimney companies don’t have a lot of work. I simply called up the company and asked them if they’d be willing to do the work for $2000 if I paid cash. The receptionist put me on hold for about two minutes, and came back and said, “sure, when would you like us to come to do the work?” It was a pretty simple thing to do to save $400!
My advice to you is to try negotiating some stuff – get over your fear and your concern that you are ripping the other party off. If you are being honest with them, there’s no need to feel guilt or shame over it. Remember that no one can force you to buy a product and, on the flip side, you can’t force anyone to sell you something. If they are not comfortable with your offer, they can always say “no.” So try it – you just might be pleasantly surprised by the result!
Check out my previous FPU posts:
- Introduction
- Lesson 1 – Super Saving
- Lesson 2 – Relating with Money
- Lesson 3 – Cash Flow Planning
- Lesson 4 – Dumping Debt
- Lesson 5 – Credit Sharks in Suits
- Lesson 6 – Buyer Beware
- Lesson 7 – Clause and Effect
Financial Peace University Lesson 7 – Clause and Effect
The Role of Insurance in your Financial Plan
This week’s lesson was about insurance – all kinds of insurance. Ramsey introduced the various types of insurance that he recommends for each person and also briefly touched on the types of insurance coverages to avoid.
The purpose of insurance is to transfer risk
Insurance is an essential financial planning tool as some types of losses can financially devastate you. For instance, if your house burns down or you are permanently disabled, these are events that can be catastrophic to your financial well being. The point of insurance then is to transfer these huge risks away from you and onto someone else. Ramsey states, “I want them to catch the catastrophes.” You can survive bills of a few thousand dollars if you have an emergency fund and good financial habits….the issue is the very rare but very large problems that your emergency fund won’t even come close to covering.
Types of Insurance that Ramsey Recommends
- Homeowner’s or Renter’s Insurance
- Auto Insurance
- Health Insurance
- Disability Insurance
- Long-Term Care Insurance
- Identity Theft Protection
- Life Insurance
Ramsey spent the majority of the lesson giving some information and tips on each insurance type.
Homeowner’s and Auto Insurance
The best way to lower your insurance premiums is to raise your deductible. If you have a full emergency fund, then raising your deductible from $250 to $500 or even $1000 should save you a significant amount on your premiums.
He also recommends carrying adequate liability coverage (at least $500,000) or carrying an umbrella personal liability policy to protect your assets (if you have significant assets to protect, that is).
Health Insurance
Again, the key to reducing your premiums is to increase your deductible, coinsurance, or maximum out of pocket expense – but never decrease your maximum lifetime benefits. Another option that Ramsey recommends is an Health Savings Account (”a really, really, really good idea”). This is a tax-sheltered savings account that you never pay taxes on (going in or coming out) if you use it for medical expenses. It is paired with a high-deductible insurance policy. Depending on your situation (especially if you are healthy), you can save a lot of money using one of these policies.
Disability Insurance
Disability insurance replaces your income if you are unable to work. The best type of disability insurance to buy (though it is usually more expensive) is occupational or “own-occ” insurance. This means your insurance payments will kick in if you can not perform the job you were educated to do. He recommends you purchase coverage for 65% of your current income. Remember, your income is your biggest asset so it is a really good idea to protect it!
Long-Term Care Insurance
LTC insurance pays for nursing home, assisted living facilities, of in-home care if you need it. Ramsey states that 69% of people over the age of 65 will require long-term care at some point. He recommends that everyone purchases LTC insurance on their 60th birthday (but not before).
Identity Theft Protection
The average victim of identity theft spends 600 hours cleaning up the mess (”you now have a new hobby”) so he recommends enrolling in a protection plan. The plan you choose should include restoration services instead of just providing credit report monitoring. (See the right sidebar for a link to save on LifeLock’s plan)
Life Insurance
Dave is a big proponent of life insurance – but not of cash value life insurance. In fact, he spent the biggest part of the class explaining why cash value life insurance is a bad idea. The most common life insurance myth, he states, is that you have a permanent need for life insurance. Imagine this scenario: twenty years from now your children are grown up and out of the house, you are completely debt free including your 15 year mortgage, and your investments have grown to a considerable sum – you are now self-insured. In this scenario, why do you need a big life insurance policy if you die?
Not only does he think that there is no permanent need for life insurance, he also points out that these life insurance policies are not a good way to invest. The biggest reason is the myriad fees that are tacked onto them. These high fees act to drastically reduce your long-term return. If you are eligible, a Roth IRA is a much, much better way to invest your money.
To be fair, I have heard other arguments for purchasing permanent life insurance such as for estate planning reasons and as another tax-advantaged way to save money – but these are both for high net-worth people. Ramsey did not touch on these reasons, possibly because they only apply to a small segment of the population.
Dave’s recommendations for purchasing life insurance:
- Buy low-cost level term insurance – term is for a specified period of time and is substantially cheaper.
- Insure your spouse – even if he/she is a stay-at-home spouse.
- Stay away from fancy options such as accidental death, return of premium, waiver of premium.
- Children only need enough for burial expenses – usually can be purchased inexpensively as a rider on your policy.
- Purchase coverage of about 10 times your income
Insurance coverages to avoid
- Credit life and disability - to pay off your loan if you die, they are generally extremely expensive compared to life insurance
- Credit card protection
- Cancer and hospital indemnity – health insurance should cover this
- Accidental death – stick to standard life insurance
- Any insurance with cash value, investments, or refund
- Pre-paid burial policies – pre-plan your burial and save up for it if you want, but don’t pay for it until it is time to pay for it.
- Mortgage life insurance – If you can’t get normal life insurance, then this might make sense; in general, though, it is decreasing term insurance that is about 10x too expensive.
- Any kind of duplicate coverage – for instance, having two health insurance policies will not ensure you have full coverage, in fact, you will end up with no coverage as the two companies fight over who is the “primary” insurer.
So, that was the lesson. There was a lot of detail in this lesson, and a lot of railing against permanent life insurance! Of course, it is not possible to provide enough detail on each individual type of insurance I mentioned in this post to be able to make an informed purchasing decision. But take the list of recommended insurances as a starting point to evaluate your current coverages and see where you may need to do a little more risk transference. Just remember to do some more indepth research before modifying or purchasing any policies.
Check out my previous FPU posts:
- Introduction
- Lesson 1 – Super Saving
- Lesson 2 – Relating with Money
- Lesson 3 – Cash Flow Planning
- Lesson 4 – Dumping Debt
- Lesson 5 – Credit Sharks in Suits
- Lesson 6 – Buyer Beware
Financial Peace University Lesson 6 – Buyer Beware
Caveat Emptor (Let the Buyer Beware)
The main purpose of this lesson was to expose us to one of the “enemies” of our financial peace – the enemy that is making poor purchasing decisions.
There is an incredible amount of marketing that we all are exposed to each and every day. Of course, the main purpose of all of this marketing is to separate us from our money (more specifically it is for specific companies to get some of that money but it’s the same thing from our point of view). This does not mean all companies are evil or something like that – they are trying to make a profit and they have to sell products and/or services to do that – but we need to be aware of how we are marketed to in order to ensure that we don’t fall prey to bad purchasing decisions.
Think of all the ways you are marketed to in any given day. There is personal selling, product positioning (there is a tremendous amount of effort that goes into where the items are placed at groceries stores, for instance), TV, radio, and internet ads, and so on and so forth (warning – editorial opinion upcoming: Remember all those debates about how TV is bad for kids to watch and influences them to act poorly and do stupid things. And then the people on the other side of the debate say, “no, that’s silly, TV doesn’t influence people.” Well, I think the fact that companies spend billions of dollars each year on TV ads pretty much proves that TV does influence people – either that or all those companies are stupid). Another method that you see often is the use of financing as a marketing tool. You often see the carrot of “90 days same as cash” used to entice you to buy something that you can’t really afford right now. An eye-opening statistic from Ramsey: 88% of 90 days same as cash contracts convert to payments!! (and remember, if they do convert, most make you pay back all the interest that accrued during those 90 days!)
Ramsey then did an interesting thing at this point in the lesson; he went through a number of different product tag-lines, stuff like “melts in your mouth and not in your hand,” and basically everyone in the audience as well as our class knew the products that every catchphrase was trumpeting – this marketing stuff works!
Developing power over purchase
In the most marketed-to culture in history, how do you resist all the temptations and only make appropriate purchasing decisions? To help us do so, Ramsey detailed five steps to follow before making any significant purchase. First, what is a significant purchase? Well, it is whatever you say it is. He recommends that anything over $300 qualifies as a significant purchase, but this will obviously be different depending on your unique circumstances – maybe higher, maybe lower.
You must develop “power over purchase” by following these steps:
- Wait overnight before purchasing – maybe in the morning that gadget you “needed” won’t seem like so much of a need anymore.
- Consider your buying motives – Ramsey states that no amount of stuff will provide true contentment or fulfillment.
- Never buy anything you do not understand – I guess this doesn’t really apply to a DVD player since most people won’t understand that – but are you sure you really (really) understand how that cash value life insurance plan works?
- Consider the “opportunity cost” of your money – If you do something with some of your money that obviously precludes you from doing something else with that same money. Ramsey told this illuminating story about a friend who wanted to purchase a new car but couldn’t force himself take the money out of his mutual fund to buy it. A number of years later he saw another guy driving that same car he had wanted. The man driving the car had just purchased it used for about $5000 while the mutual fund that Ramsey’s friend still owned was worth more than $300,000. That car had a $295,000 opportunity cost associated with it!
- Seeking the counsel of your spouse (or financial accountability partner) – self explanatory (or at least it should be…if it’s not, you have some other things to work on as well!).
Following these five steps will not guarantee that you will never make a poor purchase (you’re buying stuff all the time and nobody’s perfect) but it will go a long way towards helping you to make good purchasing decisions as often as possible.
Check out my previous FPU posts:
- Introduction
- Lesson 1 – Super Saving
- Lesson 2 – Relating with Money
- Lesson 3 – Cash Flow Planning
- Lesson 4 – Dumping Debt
- Lesson 5 – Credit Sharks in Suits
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